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Wednesday, August 03, 2011

Never fear, Barroso is here...

Commission President Jose Manuel Barroso issued a statement this afternoon in an attempt to assuage market fears over contagion to Italy and Spain. His ground-breaking approach at this possibly pivotal moment in the eurozone crisis – tell markets their wrong and remind them what’s already been done.

Unsurprisingly, it doesn’t seem to have worked.

Barroso suggested that the market attacks on Italy and Spain are “unwarranted”, adding that

“In fact, the tensions in bond markets reflect a growing concern among investors about the systemic capacity of the euro area to respond to the evolving crisis.”

Erm, we’re pretty sure that’s exactly why the fears are warranted.

Clearly, markets (along with plenty of commentators) have to spell it out for eurozone leaders – until a long term solution to the crisis is found and until countries such as Italy and Spain demonstrate the political and economic capacity to return to sustainable economic growth (and therefore debt management), markets are going to remain concerned over the spread of the crisis.

Barroso also pointed out that

"Agreement was also reached on ground-breaking measures that will reinforce the euro area’s systemic response to the crisis by enhancing the effectiveness of the European Financial Stability Facility (EFSF)"

He also stressed the need to address “the sovereign debt crisis with the means commensurate with the gravity of the situation”.

However, the EFSF reforms could now well turn into part of the problem not part of the solution, as the EFSF clearly cannot be classified as 'commensurate means' - even in its expanded role. Why? Well, as we mentioned during our panel discussion on the ECB last week (and echoed by Citigroup’s Willem Buiter recently), the deal struck that eurozone leaders the other week means that the Single Currency has effectively been left without a lender of last resort.

This role should be performed by the ECB, but due to fiscal decentralisation it cannot do so without massively engaging in fiscal policy (and therefore politics) something everyone wants to avoid. The EFSF should fill this role but cannot currently for a few reasons.

First, the expanded role of the EFSF still needs to be ratified, which will take a couple of months at least (and the ratification may still run into problems in some countries such as Finland, Netherlands and even Germany). In the meantime, it will remain unclear who the actual lender of last resort is in the eurozone (no wonder markets are jittery). Given the short term nature of this crisis, it could all be over before this issue gets settled. The ECB is loath to intervene anymore and there are already serious questions surrounding its credibility, transparency, balance sheet and the conditionality of its lending (hint: its non-existent).

Secondly, and possibly more importantly, the size of the EFSF is far from being enough to cover Spain and/or Italy (which has a bond market of €1.6tr). Increasing it to the necessary size to cover these countries, around €2tr at least, is politically impossible and undesirable as well.

Add to these issues, the persistent lack of growth and competitiveness which plague the Spanish and Italian economies and its clear why markets are worried. Unfortunately, yet again, Barroso seems to have missed the point.

2 comments:

''European Wind Energy Association (EWEA) half of the electricity requirements could be fuelled by wond power '' It appears that OE has mis-spelled 'wand'. The same wand power is needed to save the Euro.